By David Henry
(Reuters) - As Citigroup Inc
The U.S. Federal Reserve said on March 26 that it had rejected Citigroup's request to boost its dividend and buy back more shares. The news was a stinging blow to Corbat, who was charged with improving the bank's relationship with regulators in October 2012, when he was named the new CEO.
The Fed still had not explained as of earlier this week why Citigroup failed to win approval, a bank executive told Reuters. Corbat, he said, has little information as to what went wrong and why. Corbat, through a spokesman, declined to comment.
The regulator's rejection has wrecked what was left of Citigroup's chances of meeting a key profitability target that Corbat personally announced a year ago: 2015 profits equal to at least 10 percent of a measure of the bank's common equity. That ratio, known as "return on tangible common equity," is a measure of how effectively the bank uses shareholders' money to generate income.
Corbat is getting ready to talk to investors after the bank posts first quarter earnings on Monday. Even putting aside the bank's capital plan rejection, Citigroup's first-quarter results are not expected to be strong.
Net income is likely to be down 6 percent from a year earlier, according to the average analyst estimate. The reasons expected include a sharp drop in revenue from fixed-income markets and continued high legal and restructuring expenses. The bank has likely had to spend more money on legal and compliance matters after announcing it had found a $400 million loan fraud in Mexico.
Add it all up, and the bank's CEO has a lot of explaining to do, analysts said.
"All eyes are on Mike Corbat," said analyst Mike Mayo of
Banks across Wall Street are expected to post lower first quarter results, hurt by weaker trading revenue.
But Corbat and his executives have extra difficulties to contend with, and have been debating what they should do about the target for return on tangible common equity, according to the bank executive. With regulators rejecting the bank's plan for lowering its equity levels by buying back more shares and paying higher dividends, Citigroup's income is almost certain to fall short of the levels required to meet the return on equity target, analysts say.
The CEO has few palatable options now, analysts said. If he postpones resetting the target, he risks leaving investors frustrated by the lack of direction. If he reduces the target, the shares, which are already trading at lower valuations than competitors, could be hit.
Announcing a big new set of cost-cuts and layoffs to improve profitability, as the company did in December 2012, would contradict Corbat's pledge to make trimming expenses a steady, "business as usual" practice under his administration.
And reducing staff could also risk further alienating the Federal Reserve, which has said publicly that it had repeatedly found Citigroup deficient in projecting revenue and losses for its operations around the globe under a stressful scenario.
"Analysts are going to want to know how deep are these issues," said Fred Cannon of Keefe, Bruyette & Woods. "How delayed is the capital return story going to be at Citi?"
To be sure, Corbat's chances of meeting the 10 percent return on tangible common equity target looked slim before the Federal Reserve ruled, according to analyst estimates. But the denial by the regulators has made missing it a virtual certainty, Cannon said.
It seems too soon for the company to replace executives, said Cannon. "They only put this management team in place a little over a year ago," he said. Corbat became the CEO in 2012 at the urging of the current board chairman, Michael O'Neill, and he named his executive team in January 2013.
Corbat announced a series of profitability targets in March 2013 as a way for Wall Street to track his results. After having been named CEO when directors pushed Vikram Pandit out of the post, Corbat saw Citigroup shares rise steadily for about six months, largely on confidence that he and O'Neill would make the company more efficient and return capital to shareholders.
That momentum has gone, adding pressure on Corbat to handle the questions deftly on Monday. Citigroup shares trade for an industry-low fraction of their tangible book value, 85 percent, according to analyst John McDonald of Bernstein Research. That means stockholders cannot get as much for their shares as Citigroup's balance sheet shows they are worth.
And eight days after Monday's conference call Corbat is in line for more of the same kind of questioning by stockholders at the company's annual meeting in St. Louis. The price of their shares on Thursday was almost the same as at last year's meeting even though the KBW bank stock index is 23 percent higher.
CLSA's Mike Mayo, who recommended the stock after Corbat was made CEO, says he plans to go to the meeting and ask Corbat and O'Neill what corrective actions they will take.
"That is going to be the front and center question," Mayo said. "Hopefully, this is a catalyst for more aggressive change when it comes to restructuring, regulatory relations and responsibility to shareholders."
(Editing by Dan Wilchins and Eric Walsh)